C&B Notes

Whose Money Is It Anyway?

India’s Prime Minister Narendra Modi has canceled India’s highest denomination rupee bills in an effort to punish tax evaders, to reduce counterfeiting, and to formalize the informal economy. In a country where an estimated 98% of consumer payments are in cash, the inconvenience and frictional costs of this policy move are going to have short-term implications for GDP growth. Unfortunately, such a policy only treats a symptom of the problems of bureaucracy, red tape, and graft that cause such a large percentage of the economy to operate in the shadows.

In a surprise announcement Tuesday night, Prime Minister Narendra Modi said India will replace its largest-denomination bank notes with newly designed ones, a move aimed at curbing corruption, thwarting counterfeiters and dredging up what could be billions of dollars of taxable income currently stashed in the underground economy.  The new 500- and 2,000-rupee notes, worth around $7.50 and $30 respectively, will begin to circulate soon. Current 500- and 1,000-rupee bills ceased being legal tender Wednesday but can be redeemed at banks and post offices until Dec. 30…

Governments around the world have debated the merits of scaling back big bills to fight crime.  The European Central Bank began phasing out the €500 ($552) note this year.  India’s Ministry of Finance said that because the new rupee notes will look markedly different from current ones, the move would deal a blow to activities such as terrorism, drug smuggling and espionage that fake Indian currency helps finance.  The country’s central bank said 405,000 counterfeit 500- and 1,000-rupee notes were found in the banking system in the year that ended in March, representing around $4 million.  But researchers at the Indian Statistical Institute estimated this year that the total value of fake bills in circulation, including those that go undetected by banks, may be as high as $60 million.

Requiring Indians, particularly the wealthiest, to come forward with their old bills could also force them to introduce into the banking system money that had been squirreled away to avoid taxes.  Mr. Modi’s government, eager to find new revenue to fund its spending plans, has taken other steps to fight tax evasion, including allowing taxpayers this year to come clean about undeclared income without facing full penalties.  The potential windfall is huge.  Only around 20 million individuals and families, or around 1.6% of India’s population, paid any income taxes in 2013, the most recent year for which data are available.

In India, the predominance of cash is also blamed for making it easier for businessmen to pay bribes to government officials and for political parties to buy votes during elections.  “This parallel economy has got to go,” said Shaktikanta Das, the secretary for economic affairs in the finance ministry, noting that the increase in circulation of high-denomination rupee notes had outpaced the economy’s growth over the past five years.

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